Tuesday, December 31, 2013

The role of dividends

Happy New Year! As I write this 2013 is coming to an end and 2014 is right around the corner.  Hopefully 2013 was a great year, and wishing that 2014 is even better.

I don't talk much about dividends on the blog mostly because I haven't thought much of them myself.  For a brief period of time, around 2006 I had a slight interest in dividend stocks and the concept of dividend growth stocks.  The idea is that investors look for companies that have grown their dividends at a high double digit rates for years and then invest in those companies for the dividend.  In theory the investor's income stream will continue to grow 10-15%; the company's dividend growth rate.  Dividend growth investors don't seem concerned about price appreciation, only dividend growth.

A disciplined and patient dividend growth investor might start a small portfolio in their 20s and by the time they're in their mid-60s have a sizable growing income stream they can use in retirement.

The concept is alluring and works well when modeled in Excel.  It also worked well over the past thirty or forty years.  The concept broke down for myself because I had trouble paying up for companies that had growing dividends.  My concern was that while a company might not cut their dividend in a recession their price could take a sustained hit.  Dividend investors are supposed to ignore price movements and focus solely on dividends.

The dividend growth model just never stuck with me, especially after a number of dividend growth stocks such as financials ended up cratering and cutting their dividends in 2008/2009.  Many dividend growth investors experienced a double whammy, no more dividends, and a reduced principle.

Value investors often seem to ignore dividends entirely.  Many value investors in the Buffett mold disdain dividends preferring companies to reinvest at high rates of return, or to buy back shares.  If a company can profitably reinvest their profits to fuel more growth at high rates it makes sense for them to reinvest.  Similarly share buybacks make sense if managers are able to acquire shares at low valuations in quantities that are meaningful, and don't issue options that offset the buybacks.

Unfortunately many businesses don't have great reinvestment opportunities, and managers aren't the best investors, often buying back stock with the price is high and failing to do so when the price is low.  I have talked with a number of executives who tout reinvestment, but when asked how they measure if their investments are successful suddenly become silent before admitting they have no way of measuring results.

My own approach of buying average or below average businesses at extremely attractive prices has resulted in a portfolio of companies that often should not be reinvesting in their business.  Many times management at these companies isn't familiar or comfortable with share buybacks either.  This means I've had to become comfortable with companies that pay back some, or a lot of their earnings as dividends.

My own view on dividends has changed through the years.  I started like most value investors, completely ignoring them, to shifting to an approach that appreciates and looks for them in certain circumstances.  Specifically I look for a company to pay a dividend when it is foreign, or unlisted.  If a company it is neither foreign or unlisted I am content to invest at an attractive valuation and let the market do its work.

The reason I want a dividend in an unlisted or foreign company is because value realization can take longer in those circumstances, and I want to be "paid to wait."

I've found that unlisted companies, and foreign companies also tend to pay out a larger proportion of their net income as dividends.  When one looks only at the price action of a company they miss a valuable component of return.  In my 2013 year end review two companies mentioned showed lower than realized performance because I didn't factor in dividends, Argo Group and Carlo Gavazzi.  In the case of Carlo Gavazzi their dividends added an additional 7.7% to their yearly performance.

A common complaint I receive about companies I write about on this blog is that there are no catalysts and it's painful to wait for the price to appreciate on its own.  One antidote to this thinking is to invest in undervalued companies that pay out dividends.  The dividends provide a built in level of return without a catalyst, or market price action.  Investors can receive high returns (often upwards of 8-10% in Europe) while they wait for the market to realize the undervaluation.

In this manner dividends can be viewed as an essential tool for hitting a yearly performance target.  If one has a goal of earning 15% returns from their portfolio, and the portfolio yields 5% then the portfolio only needs to appreciate 10% to meet the goal.  All things considered a 10% portfolio appreciation is easier to achieve than a 15% portfolio appreciation.

I don't believe companies paying significant dividends should be specifically sought out, but I also don't believe dividends should be entirely ignored.  Somewhere in the middle is a happy medium, a place where dividends are appreciated as a component of return.  I've come to appreciate them more over the years, and as one who invests in average businesses I'd prefer management give earnings back to me to reinvest rather than squander the earnings themselves.


Tuesday, December 24, 2013

Looking back at 2013, how did my 13 picks do?

Last year about this time I suggested 13 stocks for 2013.  The stocks I picked were a subset of my overall portfolio, stocks that I felt at the time were still attractively priced.  The stocks typified the types of companies I like to invest in, somewhat dull, but often attractive on an asset basis.  Some of them are cheap earners, but first and foremost all had a margin of safety.

Here are the results:


I want to note that the performance isn't exact, I made the mistake last year of not recording the prices when I did my post.  It was hard to find historical prices for the foreign holdings, I used what appeared on my brokerage statement, or what FT.com had for the end of last year for many of the holdings.  I also didn't account for dividends, some stocks such as Argo paid significant dividends meaning the overall performance is understated maybe 1-3% or possibly more.

The picks did exceptionally well for a bunch of companies the market didn't have much faith in.  Many were priced below book value, and a few were net-nets.  For many of the companies their earnings didn't change dramatically in the past year, what changed was the market realized these companies were mis-priced and acted accordingly.

If you look at my post from last year you'll notice I excluded the category Japanese net-nets from my list above.  This is because I didn't specifically name any net-nets, and it's hard to find a way to track that pick.  I did a post on the performance of my Japanese net-nets at one point in the year that should give a good reference for how some of the category performed.

As of the post last year I held all of the stocks I had mentioned, throughout the year I ended up selling some of the positions.  I sold my stakes in Argo, Bank of the James, and Nexeya.

I don't advocate holding stocks for arbitrary time periods, rather I prefer to sell when they hit what I consider fair value whether that's in three months or three years.  An active investor in the above portfolio would have been able to do better if they sold throughout the year rather than holding onto the stocks.  At one point FRMO raced into the $8s, and Installux hit €200, both would have been sells at those points.

A question I'm sure to get in the comments if I don't answer here is "how did your personal portfolio do?"  As I mentioned above I owned all 13 stocks coming into 2013, but I also owned about 40 other stocks not mentioned in the post.  Overall my personal portfolio was up about 39%, which is something I'm very satisfied with.  The difference between the performance of my personal portfolio, and the 13 stocks in this post is that I hold a number of other companies in various stages of value creation that while I'm happy to hold I didn't consider them attractively enough priced to post on them.  Almost every stock I own in my portfolio has appeared on the blog at some point.

Here's to hoping 2014's returns are as great as 2013's!

Disclosure: Long GAV, CDU, CNRD, GWOX, HNFSB, STAL, PREC, SODI.

Friday, December 20, 2013

The gravity of the market

The market is nothing more than millions of individuals making millions of decisions at the same time.  Yet through these millions of decisions consensus forms and stocks slowly rise or decline towards their fair value.  This idea that stocks are pulled towards their fair value is what I term the gravity of the market.

I view the stock market as a spectrum of value, from zero value on one side to outrageously valued (think snapchat) on the other side.  Every traded company falls on this spectrum somewhere, and often the company's position changes hourly, daily, and yearly.  I envision my spectrum in two ways.  The first is that there is a center of gravity to the spectrum, when there are a relatively equal number of undervalued and overvalued stocks the market is in balance.  When undervalued stocks prevail the market is out of balance and is due to tip higher.  Conversely when there are too many overvalued companies, and not as many undervalued companies the market is out of balance and is due to tip lower.

The second way I visualize my spectrum is I imagine it having a mass of gravity that is constantly working to pull companies towards the center.  The market doesn't like companies that are out of balance, it is always pulling towards the center.  The force of market gravity is much stronger at the edges.  A company hovering near the center might be slightly undervalued, but the pull of gravity near the center is so weak the stock might never be pulled the last little bit.  On the other hand a company at either edge of the spectrum feels the pull of the market's gravity very strongly.  A small improvement for an undervalued company could translate into a giant advance towards the center.  A small slip-up for an overvalued company could mark a quick retreat towards the center.

I don't think many investors would dispute my theory of market gravity, it's essentially a different way of thinking about reversion to the mean.  I prefer the idea of gravity because it's a strong force, mean reversion doesn't carry as strong of a connotation.

The issue many investors have is they find the idea of market gravity mysterious, and mysterious unexplainable things are hard to accept.  I don't find the idea mysterious at all.  There are millions of investors trawling through securities worldwide.  No security is unknown, although many might only be known to a small group of people.  The process of investors looking for, talking about, and investing in stocks moves these companies towards the center of gravity.  At times it might seem like an investor buying 100 shares of a tiny pink sheet company is meaningless, but even small actions matter.  The 100 share investor might tell a friend, or email about a stock and 10,000 share investor might become interested and slightly move the price.

By nature investors can't hold back on talking about bargains they've found, they're inclined to share their ideas with friends.  Get more than two investors together and suddenly ideas will be flowing.  Likewise there is a jumpy or jittery nature to investors who invest in overvalued companies.  Many times investors will recognize they're playing with fire and are hoping to get out just before the bottom falls out of a hot stock.  Enough investors looking to avoid a dip might result in exaggerated moves with a high flying stock.

The force of the market's gravity is strong and I don't believe it's failed yet.  There is no list of stocks that have always traded at lofty valuations, and there is no list of stocks that have traded at 15% of book value forever.  Both situations are corrected eventually.

Many investors don't have the patience to wait for gravity to pull their holdings towards fair value.  Instead of believing in the force and being patient they seek out catalysts, investors who by sheer will attempt to overpower the market's gravity and push stocks to fair value themselves.  At times a catalyst can work, other times it's nothing more than a hope or a dream.

I have generally found that finding stocks on the far edge of the undervalued spectrum combined with a heavy dose of patience has resulted in satisfying returns.  Once I purchase I sit back and let the market's gravity do its work.  The question is do you believe in the force of the market's gravity?  And does your investing reflect this belief, or lack thereof?

Sunday, December 15, 2013

Versailles Financial, almost too good to be true

Illiquid community bank stocks are possibly some of the most neglected securities in the market.  Many investors won't consider making a bank investment, and further, not many bank investors are willing to venture into the dark reaches of the unlisted and illiquid stock world.  It's at the junction of these criteria (unlisted, illiquid, bank) that some of the best deals of the market can be found, Versailles Financial (VERF) is a perfect example.

Community banks can be scary to some investors, a few bad loans and the whole ship is sunk, especially with a small bank.  A few bad loans at a larger bank and no one notices.  A few bad loans, years worth of bad decisions, and bad management and the country's citizens will bail you out at a large bank, unfortunately (or fortunately) there is no one backstopping community banks.  I would prefer a bank with management making intelligent lending decisions resulting in few if any losses.

Versailles Financial is the holding company of Versailles Saving and Loan, a single branch bank located in Vesailles Ohio founded in the 1800s.  The company shares its name with the royal and well known palace in France.  Versailles Financial is neither well known, or anything of note.  Versailles Ohio is a city with a population of 2,687 people.  I grew up in Northern Ohio, and we used to joke places like Versailles had more cows than people, the joke was funny because it was often true.  The bank's link to agriculture is most evident with that fact that 16% of its loan book is for farmland.

The investment case for the bank is fairly simple, the company's current market cap is $5.9m against a tangible book value of $9.8m.  In other words they're selling for 57% of TBV.  The bank is also profitable, and has been for the last nine years, sailing through the financial crisis without a loss.  They're over capitalized as well with an 35% tier one capital ratio.  The company's nine year earning summary is shown below:


The company isn't generating record earnings which can mostly be attributed to the lack of scale the bank has with only one branch.  A bank's branch network is what works to gather deposits and generate new loan volume for the bank.  With only one branch deposit and loan growth can both be constricted, which is the case for Versailles Financial.

One item worth noting on the income summary above is the lack of provision for loan losses.  A bank's safety is derived from its balance sheet.  A bank's value is also derived from its balance sheet.  If a bank has a history of dodgy loans then it's worth discounting their loan book when valuing them with the expectation that the future might look similar to the past.  Versailles Financial's lending history has been absolutely pristine with a very small amount of loan loss provisions, and an even smaller amount of charge-offs and non performing assets.  As of the most recent quarter the bank had zero non performing loans, no loans past due, and no OREO holdings.  Sit and consider that for just one minute, every single loan that Versailles has made is paying on time, the company has zero bad loans, not even one tiny mistake by a junior lending officer, none.  Granted this could change quickly, but given their lending history I'm fairly confident in their lending ability.

A cynic might read the above paragraph and think that they are cooking the books.  I would argue the opposite.  Recently bank regulators have been coming down hard on community banks in the area of charge-offs forcing them to realize them early.  Because of this the income statements of small banks have been prematurely depressed.  The large banks aren't dealing with this, regulators have allowed them to post-pone charging off loans that haven't paid in over six months; extend and pretend is alive and well at our largest banks.

An astute reader might wonder why this bank hasn't sold yet, they appear to be a prime candidate.  Single branch banks make perfect acquisition targets, there are many costs that can be removed quickly, such as the duplicate CEO and CFO, where the savings flow straight to the bottom line.  In the case of Versailles the retirement of the CEO and CFO alone would most likely double earnings.

The bank was founded as a mutual in the 1800s and IPO'ed in 2006.  Mutual conversions are restricted from selling themselves anytime before the three year anniversary of their IPO.  The timing for Versailles wasn't that good, their three year anniversary fell in the beginning of 2009, not an ideal time to sell a bank.  Since 2009 the bank M&A market has been soft, especially for many smaller banks like Versailles, it's hard to get a deal done for a $48m (assets) bank, there just isn't much interest in that market size.

While size is a potential negative I'm comfortable investing in a small bank with pristine credit quality at 57% of TBV.  When the bank IPO'ed a reasonable valuation would have been 1.2x TBV, at this point even if the bank traded up to TBV shareholders would be satisfied.  Until the market realizes what a deal Versailles is I will continue to hold the stock and let management do what they do best, make high quality loans and collect interest.

It's worth mentioning that this is an extremely illiquid stock, it trades by appointment on occasion.  It took a few months for my initial order to fill.  Patience is rewarded with a stock like this.

Disclosure: Long VERF

Wednesday, December 11, 2013

250 posts and counting, lessons learned

I recently crossed the 250 posts threshold, and while an arbitrary number I felt a small bit of introspection on the last three years of writing this blog might be warranted.  Many writers will start a blog with a post detailing their goals for the blog and why they blog.  I've never done such a thing, and I'm not sure it matters.  My goals for this blog are not your goals, if we have different goals but you still enjoy reading then I'd say I've been successful.  But to be honest I never stated my goals because I never had any.  I like to start things and see where they go instead of starting a project with a finish in mind.  For now I'm just riding the wave of Oddball Stocks, we'll see where it takes me.

1. Writing improves thinking

Arguably the biggest gain I've had from writing this blog has been that forcing myself to write out my thoughts and investment ideas has improved my thinking.  Writing clarifies thinking, often we think ideas are clear in our mind, yet when we try to explain them they're a jumbled mess.  Many times I will uncover something I need to research further, or realize information might be more or less valuable than initially thought when I'm putting my blog pieces together.

Beware though, we are our own worst critics.  I still feel like my English grammar hasn't progressed beyond 9th grade, which is incidentally when I had to take a grammar remediation class.  I appreciate everyone trudging through what I write even when it might not be as clear as possible.  Maybe once the blog generates more than zero in revenue I will work on hiring an editor.

2. Assumptions are often flawed, a margin of safety is key

One advantage of writing everything down is it can be reviewed later.  It's amazing to see how many things I thought would happen in the future never came to pass.  Likewise it's incredible the number of investment surprises that I've experienced as well, both good and bad.

When we make assumptions it's easy to forget ones that don't work and remember ones that do.  By having everything recorded we preserve a record of our decision making that can be reviewed and studied later.

When reviewing my past investments and write-ups on the blog the concept of margin of safety has been re-enforced.  No one knows the future, if we buy a security at a large enough discount we in theory are protected against a multitude of bad surprises, and are opening ourselves to the potential for a good surprise.

3. There are no points for ideological purity

Since writing this blog I've come across a number of investing purists, maybe something isn't 'value' enough, or it isn't something Buffett would ever buy.  These investors are attached to a dogma, they invest with that dogma and are zealous about protecting the dogma.

I have no investing dogma, and most of the successful investors I've met don't either.  I'm not even sure Buffett has one, if he can turn a dime it seems he's a willing participant.  At the end of the year I want my portfolio's value to be greater than at the start of the year.  If I had to invest in net-nets, or low P/B stocks, or cash boxes, or whatever to get there it doesn't matter as long as the goal is hit and my risk is kept in check.

Investors aren't rewarded based on what school of investing they follow, they're rewarded when they buy something mis-priced, whether it's growth, or assets, or cash flow, or exotic artwork.

4. You are not the first to ever find an idea, no matter how obscure

I don't agree that a justification for a low valuation is that a stock is undiscovered.  There are always others who are aware of any potential investment either at the same time as you, or before you.  This might sound strange coming from someone who digs up what seem like many original ideas.  But I've found that in almost all investments, no matter how obscure I end up connecting with a number of readers who already knew of the company, or were aware of the situation.

The comments you see on this blog are a small snapshot of the correspondence I have with readers.  I probably have a 20:1 ratio of emails to comments, for each comment you see on this blog I have about 20 emails discussing various investments or asking questions.  I've found that there are passionate followers of even the most obscure stocks I have dug up.  It turns out the more obscure and strange something is the more responses I get in private about the company.

Given a function of how many global investors exist, the inter-connected nature of the Internet, and how easy it is to communicate and find ideas I don't think there are many hidden markets left in the world.  On the other hand there are plenty of ideas hiding in plain sight.

5. Some stocks are fun to write about, but not necessarily good investments 

This is the hardest lesson that I've learned on the blog, many stocks which are a challenge to unravel, and generate heated discussions aren't necessarily great investments.  Sometimes the best investment is a simple one like PD-Rx, or REO Plastics.  These companies were straightforward at the time of investment, undervalued assets with earnings.  But there isn't much to write about for a company like that.  Whereas some of the most interesting and complicated investments don't offer as attractive of a return.

It's difficult writing to find a balance between posts readers might enjoy, and posts that provide potential profitable investments.  I clearly enjoy unravelling a good mystery, but if I filled my portfolio with mystery stocks I would probably have sub-par returns.

I've purchased a number of small companies where an hour of research is all I need to make an extremely educated investment.  That includes reading all of the news and multiple years worth of annual reports.  These simple companies also have generated substantial returns for my portfolio as well.

In the past year I've tried to increase the mix of topics I post about, great ideas, ideas I passed on, general investment thoughts, and investment mysteries.  With a greater mix it's harder to get stuck on one topic for too long, which hopefully lessons any potential for boredom from reading the site.

Final thoughts

I've enjoyed writing this blog, it's helped me develop as an investor, helped me meet many great people, and hopefully made a little money for many readers.  Here's to the next 250 posts!

Thursday, December 5, 2013

CIBL, a discounted pile of cash with high optionality

An oft-written about investment on this blog, CIBL (ticker CIBY) has finally come full circle.  What started as a complicated mess of wireless partnerships and TV stations has finally been unwound into a pile of cash and two new investments.

If you have the time I'd recommend reading the full series on CIBL, part 1, part 2, part 3.

For the rest of you I'll provide a quick recap.  CIBL was spun off from telecommunications company LICT in 2008.  CIBL as originally spun off was simply a collection of ownership interests in various joint ventures: two wireless towers in New Mexico, and interests in two TV stations in Iowa.  In my initial post I speculated that the company could be worth between $1249 and $3314 if they were to sell out of their ownership interests.

The company had stated in their financial reports that they had received an offer to buy their wireless ownership interests for a value that was materially higher than the current share price.  Even with a clear message from management regarding their undervaluation the market didn't seem to care.  The Board, which includes Mario Gabelli, a famed value investor with a 27% ownership stake seems very shareholder focused, both on realizing value, and undertaking shareholder friendly actions.

Fast forward close to two years later, CIBL has followed through and sold out of their wireless towers and TV station ownership interests for a value that is slightly higher than my low end estimate.  It's fascinating to read over my previous posts, and especially the comments with the lens of knowing how things worked out.  My estimate of value for the TV stations was low, my highest estimate of value was $13.8m, and they sold the stations for $14.5m.  On the other hand my wireless tower valuation was too aggressive, the final sale was for $31m, whereas I estimated they could be worth anywhere between $25m and $68m.

Amazingly even with management's value unlocking actions CIBL still looks cheap.  Here is a breakdown of their current assets:

The company has a large amount of cash from the sell off of their wireless towers, as well as from distributions from past operations.  They also have $352 per share receivable net of taxes from the sale of their TV stations.  Once the sale closes, which could be a while due to regulatory issues, the company will have close to $1400 per share in cash.

Along with their cash the company holds two other investments, a 1.26% stake in Solix, and a 51% ownership interest in ICTC, a rural telecom company.

The company's Solix stake is non-traded, but Dave Waters found they did $91m in revenue in 2012 when he wrote about CIBL, I am valuing the stake at 1x of sales.

When evaluating the latest price against the sum of the parts detailed about CIBL is about 20% undervalued.  The stock would need to rise about 25% to trade at the value of its assets, which would be a nice appreciation for shareholders, but nothing to write home about.

There are two factors that I believe make CIBL more attractive than the numbers initially suggest, potential hidden value at CIBL, and Gabelli's capital allocation skills.

As mentioned above Mario Gabelli owns 27% of the company and serves as a Director.  Gabelli is a well known value investor who runs GAMCO Investors a $30b asset management firm that runs a number of highly rated mutual funds.  While the CIBL stake is nothing more than a speck to his overall fortune he does seem to be actively involved in pushing for value creation.  The real kicker for CIBL is that Gabelli and his associates will have a pile of cash to invest.  Given how well they've done in the past I don't mind letting them invest some of this cash for me.

The second factor is potential hidden value at ICTC itself.  CIBL has worked over the past year to increase their stake in ICTC at $22 a share to a 50% ownership stake.  When I initially looked at the ICTC financial statements I couldn't understand why CIBL was interested in buying shares.  After thoughtfully reconsidering the statements I began to see shades of hidden value, much like CIBL looked like when I initially researched them.

ICTC is a holding company for a rural telecom company as well as a CLEC and a few other assorted investments.  The company is selling for slightly more than stated book value and a reasonable earnings multiple of 12.6.

Gabelli & Co did well unwinding the complicated ownership interests and joint ventures of CIBL and turning them into cash.  My suspicion is that they're intending to do the same thing with ICTC.

ICTC has a few sources of value, the first is the telecommunications operating company.  The company has 3200 customers that are generating $1274 in revenue per customer.  This is compared to Frontier Communications who's customers are generating $1385 in revenue per customer.  I will take ICTC's market value as their fair value; let's assume the telecommunications company is worth $8.2m or 12x earnings.  Then the company has $2.9m in cash, and a slightly smaller amount of debt.  There are two ways to look at this cash and debt.  The first is that it might travel with the telecom company in an acquisition.  The debt might be attached to communications facilities or equipment, and since it's easily serviceable it wouldn't need to be paid off.  The second way is to net the cash and debt effectively canceling them out, I think this is probably appropriate.

ICTC has three investment holdings, an ownership stake in a North Dakota telecommunications carrier, a few miscellaneous investments and a partnership interest in a rural wireless tower.  Their investments are starting to sound like CIBL's investments.  ICTC carries their tower interests for $144k, which is understated considering it paid them over $250k in distributions last year.  If the company were to sell the wireless tower interest at a similar multiple that CIBL received for their New Mexico towers it's presume that they might receive $1.7m for their interest.  My guess is that their North Dakota ownership interest is similarly undervalued, although without more details it's impossible to know by how much.  If ICTC were to unwind in a piecemeal fashion I don't think it's a stretch to think they might be able to realize another $150 p/s in value for CIBL bringing CIBL's total asset value to about $1800.

Overall CIBL isn't a slam dunk investment, but it's the type of asymmetric investment I like, buying safety at a discount with the possibility of an upside surprise.  What makes the upside even more attractive is that the company has a history of profitably unwinding complicated investments, and a savvy investor is helping to take part in the process.

Disclosure: Long CIBL